By Ian McDonald, Principal
Interface Financial Group
Small-business banking is good for the banking business. News abounds of large-bank marketing efforts directed at building their small-business relationships: they are doing everything from knocking on doors to redesigning their websites.
While small businesses make great bank customers and are often more profitable to the bank than are large businesses, they present unique challenges for bankers. One issue many small businesses face is maintaining cash flow. This is especially problematic for firms with large customers. It is now common practice for large companies to employ sophisticated cash management strategies that stretch the time span for invoice payments as long as possible. That is great for the large firm, but it can put the vendor, the bank’s client, in an insurmountable cash crunch. Meeting operating expenses, or even financing the next job from a client, becomes a challenge.
Cash flow problems that extend over several months can add a difficult situation to small firms, even those with excellent business prospects and great customers. To make matters worse, these small companies frequently do not meet the credit requirements of their own banks. Therefore, their bankers (who know the client and the problems best) often cannot come to their assistance when these smaller clients need them the most. To their frustration, small business bankers often find themselves with their hands tied and unable to help a good customer. This is the main reason that those of us in the alternative financing business are getting more and more small business clients referred to us by banking institutions.
As the push to build the small business segment continues, banks are recognizing that “accounts receivable financing,” or factoring, as it is commonly known, can be a good option for their clients.
The way factoring (and invoice discounting) works is straightforward. Factors purchase outstanding invoices and give the client an immediate cash advance for a portion of the value of the invoices. Then, at the appropriate time, the factor collects on the invoice from the client’s customer.
The cost of factoring is determined by a number of variables – including the volume of the transactions, length of contract, bank’s customers creditworthiness and most important, the creditworthiness of the client’s customer who will be paying the invoice. Small to mid-sized business clients make excellent candidates for factoring and invoice discounting, as do clients with slow paying customers who are generally creditworthy.
Bankers who want to help their small business clients with some of their more difficult situations should familiarize themselves with the process of factoring and invoice discounting. Factoring and invoice discounting are highly specialized businesses – it is important that banks be familiar with the potential outcomes and costs of engaging a specialty finance partner, like a factor or invoice discounter.
Much as it probably pains some bank small-business relationship managers to refer clients to another financing source, the results speak for themselves. Many of these small businesses are just not in a condition that makes them bankable. By making a referral to a spot factor, like Interface Financial Group, banks can be an asset to their clients without putting the bank at further risk. You can retain an enhanced depository relationship for the time needed to help the small business client. This can be a process to help the small business work through the cash flow obstacles, and return to the bank in a better, more bankable condition.
Portions of this article taken from “Factors to Help Your Bank Help Small Business Clients”, as written by Lewis Y. Faber, Chairman of Yale Capital, Inc., as it appeared in MCC Financial Notes, Feb, 2005.
Ian McDonald can be contacted at firstname.lastname@example.org or 320-266-4155.